Saudi LPG Pricing - Background.

In the early 1980s, the state oil and mining organisation Petromin controlled the sector of associated gas and the country's Master Gas System (MGS), which came on stream with a huge capacity to produce LPG and NGL for export. Petromin's governor at the time, Dr. Abdel Hady Taher, wanted to expand the share of LPG in both the power and industrial sectors with emphasis on Japan - by far the largest market for Middle East gas liquids.

The big Japanese trading and power companies advised Taher that, for LPG to have a major long-term share of the energy business, prices of butane and propane must be stable and must compete with the other sources of energy. Japan's petrochemical producers, dependent on naphtha for their feedstock, had the same view. Petromin then adopted a pricing formula based on the market value of Arabian Light crude oil in BTU terms, less a percentage that was to rise gradually.

In agreement with Japanese business leaders, Petromin established a long-term schedule for the formula, including phased increases in the percentage below the calorific value of Arabian Light. In return, a number of Japanese trading houses and refiners signed purchase contracts with Petromin which were to be renewed every five years. Some companies from Japan and other Asian countries signed annual contracts, and so did a number of Western oil majors. The understanding was that Japan's trading giants, which were the suppliers to that country's power and gas utilities and petrochemical producers, would keep promoting LPG for as long as it was competitive.

As a result, most of Petromin's exports of LPG went to Japan. Later South Korea, Taiwan and other Asian countries became term clients for Saudi LPG. Petromin was the price setter for all butane and propane trades east of Suez, including LPG exports from fellow GCC states, Indonesia and other Asian countries. This in turn was to influence trades west of Suez, with Turkey and Brazil having become important clients of Petromin along with the oil majors. But Taher was dismissed in late 1986 and from then on Petromin's influence in Saudi Arabia declined.

Samarec, established in early 1989 as the operating arm of Petromin, kept that pricing formula in force and went a step further by establishing a special price for LPG supplied to Japanese and other petrochemical producers. The latter price was to compete with naphtha. Soon, however, Samarec discovered that traders in Saudi LPG on both sides of Suez were taking most of the benefits from the old Petromin formula and several new companies emerged to trade in Saudi butane and propane. As a result, Samarec in Saudi Arabia was criticised for having lost revenue opportunities to traders.

So Samarec adopted the "Saudi price" (SP), based on a combination of the Petromin formula (i.e., the calorific value of Arabian Light) and the outcome of a monthly tender for one LPG cargo of 22,500 tons. The latter element determined the premium which term customers had to pay over the parity. But the SP still was below subsequent spot market quotations and thus allowed term customers to make an extra profit by reselling some of their cargoes on the spot market. At times, this profit came to more than $50/ton C&P-Japan.

Saudi Aramco absorbed Samarec as from mid-1993 and was unhappy with the latter's pricing formula. But it could not change it abruptly because of contract commitments to term lifters. In January 1994, the SP was as low as $93/ton for propane and $93.50/ton for butane, allowing some terms clients to make a spot trading profit of nearly $30/ton. Moreover, the large size of the cargo tendered monthly meant that only few big traders could bid and competition was limited.

So, although the old Petromin formula had helped boost LPG market shares considerably, the gap caused between the SP and the spot market meant a steady loss of revenue opportunities.